Management, cost and cash control techniques
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by Harold Berry
United Transport Overseas Ltd THE NATURE of the road transport industry has changed quite materially in the past few years, but because this has been gradual we have perhaps not noticed what has been happening. The change has been brought about by three major factors—ie elimination of the old licensing system, the advent of EEC membership which has brought many operators and customers into touch with the ramifications of road haulage in mainland Europe, and lastly the higher degree of specialisation in transport, particularly embracing unit loads and the concept of a total distribution service, not only nationally but internationally.
The principal outcome of these changes is that transport management is getting more complicated, transport organisations are tending to get larger and therefore the optimum standard of management quality is increasing.
Dealing with management techniques—there are three observations I wish to make. The first deals with size. It is possible for a road transport business to be too large for effective management. In United Transport we do not like a company to expand to such a size that the personality and influence of the general manager becomes remote from both staff and customers. Our experience has taught us that this can lead to low profitability. For every man that can manage a company with 500 vehicles or more there are at least 20 who can successfully run a business with 100 units, There is therefore an optimum size for a company and we would have no hesitation in splitting a business which we felt was becoming managerially slack because of its size.
The second observation is that in freight operations the channel and chain of command must be kept short. This not only enables the general manager to dominate the company but speeds up the whole process of the circulation of information and decision-making. This seems to me to be one of the fundamental differences between the private and public sectors in transport, not only in the UK but in many overseas territories, too. Short lines of control also enable a business to decentralise authority and responsibility more easily, and without question the best way to train potential managers is to put them early on at the receiving end of responsibility. This has its own built-in reward because the most satisfying feature in transport is to be given responsibility and thereby the opportunity for achievement and the self-satisfaction which goes hand-in-hand with this. The other feature which flows as an added benefit from decentralised responsibility is the improvement in co-operation, discipline and loyalty, and individual self-discipline. Responsibility, loyalty and discipline must go hand-in-hand and feed on each other because in the final analysis it is job satisfaction at all levels which creates a climate successful and profitable ness. Furthermore, the r( senior management bet that much easier if res ibility has been effec diluted. Staff problems h knack of resolving therm much more easily, too, chain of command is and responsibility is dece ised. third management obion I would like to make with accountability. It rs not how small—or large—a transport bus iyou have, there is no ative to a regular reportystem which, at least a month, expresses in r terms the outcome of tewardship. It is a truism lore transport businesses failed because they d the reality of events, revealed by regular its, than from any other and it is interesting to that my experience in e and Australia shows allure to be more prevalere than in the UK. You ?member that one of the enefits we thought would !ronl the 1968 Transport was the necessity that iort managers would be ed to have a basic knowof transport costing, and a great pity that this e of the Act has been • to go by default.
ting techniques are, of !, not a substitute for eal experience managebut only an aid to such ;ement. Costing informa:an assist a manager to a decision: it cannot or I not make the decision business decisions result the exercise of judgment, 1 by the best possible teflon and advice, of costing is only one. The I point I would make is the more simple an riting system the quicker ready for use and the effective it will be. So on simplicity.
all United companies— here are well over 100 the world—we receive set of monthly accounts, dly within three weeks e month end, and the n is so designed that it es the requirements of evels of management ;hout the Group.
ay, utilisation of the and physical assets of nsport company is unonably the most importttor in profitability. It is also true that four items of cost in transport represent, in most companies at least, 75 per cent of total cost. These four items are labour, vehicles, fuel and tyres. It follows, therefore, that any costing system must pay particular attention to these four items and their productivity. My experience is that if you can keep tight weekly control on the utilisation of these four elements of cost then efficient operating automatically follows.
Down-time the key
Dealing first with vehicles, work done and therefore productivity is best measured by the miles operated per week or month. All over the world road conditions are improving and therefore mileage _potential can be stepped up. We are finding at the moment, when fleet sizes are being reduced because of the fall-off in revenue, that this provides an excellent opportunity to review vehicle utilisation, with a view to increasing the output of men and machines, and we have had to be severe in fleet reductions to achieve this end.
This kind of vehicle utilisation can only be achieved if the equipment is in first-class mechanical condition, and this reasoning has led us in United to a further basic appreciation, 'which is that we must radically shorten the expected economic life of our tractors. In large fleets we are aiming to reduce the average life to three/ four years and in this way we expect and are achieving a minimum amount of downtime on our units. In our judgment, down-time—ie a vehicle off the road for mechanical repair or maintenance—is the most expensive item in freight operating today. It is more costly than delays due to traffic congestion or poor sclieduling. Costing methods must therefore provide regular information regarding mileage operated and time off the road for maintenance, accidents or lack of traffic. We consider this information so important that it forms part of the regular statistics in each depot and company. Each company, according to its varying operating circumstances, knows the amount of down-time which is permissible before the units move from profit contributors to loss contributors.
Costing systems must also provide, again on a regular basis, efficient controls for fuel and tyres. We keep simple monthly records of mileage, fuel and oil used on each vehicle and calculate each month on a cumulative basis the mileage per gallon for fuel and oil. Our engineers take action immediately consumption figures go up. As regards tyres, our main control is through physical inspection, and only in a secondary way through monetary costs. We talk about "tyre maintenance" in the same way as we talk about "vehicle maintenance." Road conditions and tyre prices can vary so considerably that control and utilisation on a cost per mile basis can only provide a rough guide to true tyre costs.
Inflation accounting
Inflation, cash control and replacement accounting are all interlocked and the question we all have to ask ourselves is—shall I be the next victim? Whatever the Ryder Report on British Leyland may or may not have proved, it showed unequivocably that some form of inflation accounting is a matter of desperate urgency for large sections of British industry and this certainly applies to the road transport industry. New investment is financed out of depreciation money, retained profits and new capital. In British Leyland's case new capital had been hard to come by, profitability had not been high enough to build up adequate retentions and because of inflation the amounts set aside for plant depreciation have proved inadequate. How many transport businesses here today are faced with this same problem? For some years now lots of us have been spending far too little on replacing fixed capital, and have also been running down our working capital. Inflation means, however, that even to maintain the expenditure on equipment replacement and to finance working capital on the same level in real terms, much higher levels of profit are required.
The decline in corporate profitability has been most marked in the past five years when world inflation has drastically accelerated. The reasons why real profits are depressed by inflation are well known. If depreciation is based on the original cost of a vehicle and the new vehicle will cost two or three times as much, a great deal has to be taken out of profits simply to provide for the same productive capacity. How many operators have their depreciation charge calculated on replacement costs for their internal management accounts and for use in constructing your rates and quotations? Very few, I would guess. But even more devastating is the need to find extra working capital out of profits. Inflation means higher prices which means higher levels of debtors. Have you attempted to work out how much working capital you currently require to do the same amount of business as you did 12 months ago? If this money cannot be found then the business has to be reduced in real size. It may be argued that borrowing can tide a business over periods of exceptional inflation. To some extent this is possible provided the business is sound and has good prospects of profitable growth. All of this means that when inflation is high, profits — expressed in current terms — have to rise and they must rise by considerably more than the amount of inflation.
There is no doubt that last year's liquidity crisis would have been recognised much earlier if companies had been accounting properly for inflation.
Tackle inflation now
So how should we here and now be tackling inflation accounting to make it a fact of life? There are one or two practical actions which can be introduced at any time and need no sophisticated calculations. Apart from their relative simplicity, they also have the apparent advantage of being relatively painless, too. Furthermore, these methods work and have been in use by the United Group long before inflation became the bogy it is today. The first method is to adopt a much shorter book life for your vehicles than the anticipated physical life. If, for example, a vehicle costs £10,000 and you anticipate it will last five years, then normally you will provide £2,000 per annum depreciation, assuming no residual value. If, in fact, you write it off over four years then by the end of five years' service you have funded £12,500 towards the cost of replacement. This only provides for inflation at the rate of 25 per cent over five years—or 5 per cent per annum—so this is not enough under current circumstances, but at least it is a start. If, in fact, you write the vehicle off in three years, ie at the rate of £3,300 per annum, then after five years' actual use you would have provided £16,500 to replace the five-year-old vehicle, originally costing £10,000. This provides for inflation at an annual rate of 13 per cent, which is somewhere near reality.
The United Transport Group has followed this practice for many years because in the good old days when a 1951 pound kept its same value in, say, 1960 it was the best regular and painless method of providing for development finance. Right now it is also helping us with our inflation cum-replacement problems. This method also has one further and important advantage: by increasing the depreciation costs currently we are helping to compel ourselves to -increase our rates and charges currently, bearing in mind what I said earlier that current profits have to provide for future inflation now. In many companies, I strongly suspect, it will also help to catch up on unfunded past inflation. I strongly urge you to tackle this matter now and, at the same time, help the industry to establish a more realistic level of rates at once.
My second suggestion is again simple but involves circumstances other than finance. It deals with the time cycle for replacing vehicles. Inflation and consequently vehicle costs apart, we in United have found that it pays handsomely to shorten the period between buying and disposing of vehicles. In road transport today vehicle down-time, as I have already said, is the most expensive factor of all. We all know that labour and vehicle operating costs represent 70 to 80 per cent of total costs, so unless maximum utilisation of both factors is achieved it boomerangs at once on profits. In order to achieve this level, equipment must be in tip-top condition, and generally speaking this means having a modern fleet. In normal circumstances, we expect to obtain a vehicle utilisation of no less than 90 per cent and strive for a norm of 95 per cent. This only leaves a small margin for maintenance, accidents and other non-revenueearning time. During the present period of traffic fall-off this has meant a realistic, if sometimes painful, cutback in fleet strengths and crews. With our high-mileage units we are now adopting a fouryear book life but are regularly replacing the units after two or three years before heavy maintenance costs—but More particularly heavy maintenance time—are required. This policy of updating the fleet regularly does, of course, have a substantial side benefit in the inflation field because if, on average, your line haul fleet is no more than two or three years old then the difference betwen buying, tradingin and replacement prices is not so large. If, therefore, there is room to improve utilisation concurrently with a higher replacement cost, it is surprising what little increase in cost per mile there is. As an example, a tractor costing £10,000 and averaging 100,000 miles per annum will cost 2.5ppm depreciation over a four-year life. However, a vehicle costing £15,000 — 50 per cent more — and written off over three years with a residual value of £3,000 but operating at 120,000 miles per annum, will cost 3.3ppm depreciation —an increase of only 0.8ppm. If you include other fixed costs such as insurance, road licences, etc this will tend to make the gap smaller.
However, this hopeful optimum operating arrangement is, as we all know, more than ever difficult to sustain, let alone attain, under current depressed conditions. My advice remains, however, that it is better to cut back at an early stage and thereby attempt to maintain •high vehicle , and crew utilisation rather than "hang on" for the better times with worsening operating ' standards. During periods of low volume and intense competition our operating standards and methods have to be at their best, not their mediocre best, and this is the time to regularly review operating methods and techniques with the constant thought of improving vehicle and human productivity.
Borrowing money
A third method of coping with inflation is to finance vehicle replacements or development with borrowed money, and there is no doubt whatsoever that this is, as a counterinflation procedure, financially sound. Technically it can be argued that inflation works for the benefit of the borrower as his future liability is to repay the debt in ever-depreciating pound units. But I don't have to remind operators of the risks involved. We have all witnessed during the past 12 months the tragedy of large businesses who have over borrowed and have then found their profitability at stake. There is one golden rule which must be obeyed by all who wish to use external loan finance in road transport, and that is that the use of this money, as applied, must be profitable, at the right level, as soon as the investment is put _ to work. If you have to borrow money at 14 per cent then its use must earn and continue to earn more than this before the exercise is worthwhile at all. Furthermore, loans of this nature have to be repaid usually at intervals linked to the profitable life of the asset involved. In other words, your cash flow from depreciation provides the money to meet the loan repayments. So there are two rules which have to be obeyed : one—you must earn a rate of profit continuously in excess of the cost of borrowing: and two—your loan repayments must be geared to the effective life of the assets, making full allowance for accidents, interruptions to work and reducing activity.
Higher permitted weights
Of course, we are all aware of a further line of action which is available to the government of the day and would be the most dramatic and significant of all aids to the industry—I refer to the increase in the legal payload capacity. If ever there was a time when the Government could help our industry by administrative action without cost to itself, it would be to increase the gross vehicle weight to the proposed Continental level and so enable us to improve our unit load revenues, not only here but across the Channel.
All the problems I have been mentioning so far end up by affecting the cash flow, or the lack of it. The stark reality of inflation, trading, profits, losses—reflect their influence through the movement of cash, and it follows that a regular monitoring of cash flow by means of consistent and detailed budgets becomes more essential than ever. More businesses today of all sizes are paying more attention to their monthly cash position than their profit and loss position. A properly constructed cash budget brings to account the cash impact of a whole business activity—profits, movements in working capital, capital receipts and expenditure, tax payments, leasing— everything. In the United Group we have always insisted that every company month updates its cash statement and is respor for regulating its own facilities within the limits down. We feel it is essi that this is a matter le the responsibility of operating company becat: has its own built-in disc ary measures. You spend the money you ha earned or collected and bank manager polices the come of this exercise.
A number of intere results are emerging frc more diligent control of and liquidity. Lots of co nies have improved their position by running stocks, either because the: manage with a perman lower level or, more pal larly, because they are ducing less. Further imp ments have arisen bec credit is now better contt but again this apparent provement is more likely to the overall reductio debtor levels because o duced business. If and • business does improve the of working capital to fir this expansion Will be a r problem for many comp unless it is provided for E of requirement, for at moment many transport nesses are deluding thems that they haven't a cu cash problem. What is happening in most cast that they have cut activity back and also def any plant replacements.
Weekly bills
-There are one or two p cal changes which we introduced to assist our flow. We now bill our / customers on a weekly 1 and they are responding in Europe, where we mak' bursements for custc outside the normal tran charge, we are raisin financing debit which than compensates us fo: cost of our outstandings in our traffics to the IV East we issue through Bi Lading which we dis immediately upon loz through the banks.